Definition and Meaning of Price Discrimination - Paper Example

Price discrimination is the business practice of charging different prices for a similar/ same product or service at various customers (Anderson & Dana Jr, 2009, 982). Price discrimination does not mean that the cost of production or supply of the product or service is different. Price discrimination is easily applicable in a monopolistic market where a monopolistic company sells in various markets same units of the same product at different prices. It involves categorizing customers into groups based on certain attributes and charging each group differently from the other. In some cases sellers using price discrimination charge customers the maximum amount of money that the client may be willing to pay for the product or service (Damiano & Li, 2007,245). However, price discrimination is not applicable in a perfect competition market. Even if a company operating in a perfect competition market can supply to two separate markets at different prices the high demand and supply in each of them would eventually make the price equal in the two markets. In a perfect competition market, if a supplier tried selling a product at a higher price to a particular market or customers, every other supplier would also compete to sell in that particular market and reap maximum profit because of the higher price. Eventually, large supply would be experienced, and competition would level the price. Price discrimination is only possible in an imperfect market such as monopolistic and impossible in a perfect market.

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Sellers use price discrimination in situations where the profit level derived from charging different prices to different customers/ groups is higher than combining the market and charging a common price. In making decision on whether to implement price discrimination as a pricing strategy the seller must evaluate the demand elasticity in the sub-markets. Price discrimination involves charging relatively higher prices in the sub-markets with relatively inelastic demand whereas the sub-markets with relatively elastic demand are charged lower prices (Vyn & Hailu, 2015, 450).

There are three types of price discrimination, and these include first-degree, second-degree and third-degree price discriminations. The first-degree price discrimination is personal, and it is based on the income of the buyer or consumer. It involves a seller selling a product or service to customers at the highest price at which they are willing to pay (Damiano & Li, 2007, 247). It is applicable in service provisions such as legal consultation and medical services where lawyers and doctors charge their service according to the economic status of the client they are dealing with. The second-degree price discrimination is based on the nature (such as quality and size) of the product. In this type of price discrimination the seller segregates customers depending on the quantity, they are willing to consume and charges different prices for different amounts. For instance, the seller may decide to sell 10 kg of a product a lower price than 1 kg. The third-degree price discrimination is based on consumer demographics such as the age, sex and other statuses of the user (Cowan, 2012, 333). It involves a seller selling a product or service at different prices for different categories or groups of customers (Pires & Jorge, 2012, 672). For instance, a telecommunication company may decide to introduce cheaper tariffs for students and teenagers while the working class is charged higher call rates for the same amount of call time.

Price discrimination as a business and pricing strategy should not be misused by companies or sellers because it has some disadvantages. It should be used where there is a genuine need. Price discrimination minimizes welfare for some consumers especially those that are charged higher prices. It also forces some consumers to lose out on consumer surplus because it is transferred to the seller rather than the consumers (Cowan, 2012, 335). In cases of perfectly or relatively inelastic demand consumers may be exploited by producers who take advantage of consumer sovereignty. In this case, the producers charge high prices and force consumers to pay prices that are higher than what they are willing because they know the demand for the product or service will always be there. Also, price discrimination can lead to misuse of monopoly power especially if a high percentage of the producers customers are the ones paying higher prices compared to the insignificant percentage that pays lower prices.

Even if price discrimination may be unpleasant to particular consumer groups when viewed in a practical sense, it may be the most viable way to keep some producers running their businesses (Bergemann, Brooks & Morris, 2015, 923). Price discrimination is advantageous to poorer consumers or lower income earners. In the case where every customer is charged the maximum price, he or she is willing to pay the low-income consumers always pay a lower price because it is the maximum amount they are ready to part with to get a product or service. Price discrimination also improves the living and economic standards by providing necessary service where required. In some instances, it might be extremely expensive to provide vital services to low-income consumers without discrimination. In this case, the service provider will charge higher prices to those who can afford it and charge lower prices to low-income or poorer consumers. In other instances, it might be expensive to provide a service to certain areas such as remote mountains n the upcountry. Instead of a provider such as postal services cutting out such valuable service in such areas, it would simply charge them a higher price and thus make it possible to keep running the service there. Price discrimination helps producers get higher revenues which can be in turn invested in research and development and ultimately lead to improved service or products.

Conditions for price discrimination

There are various conditions under which price discrimination should take place. They include the ones discussed in the following paragraphs.

Market Imperfections: As mentioned earlier the most common condition under which price discrimination takes place is under imperfect market. When the market is imperfect, it Is hard for customers to move from one market to another either because of lack of knowledge of market inflexibility for example in the case of a monopolistic market (Kopel, Loffler & Pfeiffer, 2016, 1232). Therefore, the seller can study his or her market and segregate the customers or real markets into separate parts to which he will sell the product or service at different prices. In an imperfect market, the seller can dictate the price which is impossible in the case of a perfect market where the market demand and supply control the price thus forcing the seller to take the price in the market.

Prevention of resale: Price discrimination cannot occur in a market where consumers can buy products and easily resale to the consumer who would have paid a higher price (Stole, 2007, 2227). For a seller to implement price discrimination strategy, he or she has to be able to prevent resale. For instance, if the seller had planned to charge a lower price to students he or she can prevent resale by introducing conditions which one must fulfill and prove he or she is a student before taking advantage of the lower prices. For instance, the seller may require legitimate national and student identity cards before giving student discounts. This condition will prevent second-hand shops, merchants and other retailers from buying at a lower price using the student discounts to resale to customers who would have paid higher prices.

Agreement among Rival Sellers: A group of vendors offering similar product or services can come together and agree on how to charge different customers. Agreement among competing seller on how to implement price discrimination is more common and possible in the sale of direct service since there is no possibility of resale (Cowan, 2007, 424). For example surgeons, lawyers and other service providers may agree to charge high prices to wealthy clients and low prices to poor clients.

Identification of different market segments: This factor is another essential condition for price discrimination. If the seller can be able to identify and group the customers into the various groups with different price elasticity of demand, then price discrimination would be easy to implement (Bergemann, Brooks & Morris, 2015, 928). The seller would then sell at different prices to customers with different price elasticity of demand. For instance, the wealthy customers have inelastic demand and would continue to purchase a product even if the price increases. The seller can take advantage of their price inelasticity and make more revenue by charging higher prices. Vendors can access information to group their customers according to price elasticity by conducting market intelligence from such sources as browser history and cookies. Firms selling online such as Amazon are most likely to benefit from this condition. It is possible to learn about customers interests as well as social and economic status by analyzing their digital footprint. This information can be used to implement price discrimination. In this case, the seller will make profits as long as the marginal revenue is higher than marginal cost.

Geographical or Tariff Barriers: Price discrimination can take place where the markets to which the seller is supplying a similar product at different prices is separated by geographical distance and tariffs barriers. For instance, a seller can charge a small price in foreign markets and a higher price for products sold in the home market. However, the seller must be sure that it will not be possible for retailers to buy the product from the foreign markets and resale it back home at the high prices (Jiang, 2007, 130). The two markets must be separated by tariffs such that importing the product back home will be expensive and therefore impossible. There are reasons why sellers would sell their products at lower prices in foreign markets. Sometimes the products are sold at prices lowers than the production cost. The main cause of this is to acquire foreign currency.

Differentiated Products: Sellers can exercise price discrimination when the buyer needs the same service for differentiated products. For instance, a seller offering transport service may charge lower transportation price for copper and a higher price for carrying coal. Differentiated products as a condition for price discrimination applies in the case where a buyer cannot turn the demand for one product to the other and thus has no option but to pay the high price charged by the seller for the particular product or service (Cowan, 2007, 420).

Customer ignorance: Some customers have the psychology of buying the product that is sold at a high price because they view it to be of the best quality. Customers belonging to the wealthy class may pay a higher price for a product without knowing that the same product is being sold to another group of clients at a lower price (Jiang, 2007, 118). Therefore fo...